Archive for the Macroeconomics Category

China needs home-grown entrepreneurs.

Posted in Business Culture in China, Macroeconomics with tags , , , , on February 10, 2015 by Ben Brown
Chongqing at night

Chongqing at night

The changing economy of the People’s Republic fascinates me.

I remember about five years ago I told a friend of mine I that China’s government would soon be forced to create policy enforcing IP laws and creating an environment more conducive to small businesses, entrepreneurial endeavors, creativity and innovation. I told him my suspicion was that we could look to Chinese banking systems to see when these types of changes were most likely to take effect. I said that in a few years China’s export manufacturing industry would mature. Its growth rate would slow. The booming real estate industry would also outpace the rate of qualified buyers entering the city. Furthermore, a lot of China’s real estate boom has been helped by subsidies in the form of instant property value: unlike the rest of the world, many Chinese in their 50s and above were given houses by the government. When the developer comes to negotiate with the homeowner they offer either cash or a new home. A successful family that had already turned their old communist-era apartment into a rental property and bought their own place could take the cash and buy a car, invest in stocks, buy a home for their children, etc. Nobody had to pay back home loans.

Just by looking around Chongqing, I would guess that the majority of those old apartment blocks have now been torn down. There are still people who own loan-free property but the apartments are fairly new and offers to buy a whole complex by a prospective developer are becoming increasingly sparse. Unsurprisingly, the lack of loan-free equity lying around that supplemented the construction boom has successfully slowed prices even in a city like Chongqing, whose GDP grew at 13% in 2013, making it the fastest-growing city in China.

Export manufacturing has also slowed. This was to be expected. As costs along the accessible coast have risen, low-cost manufacturing jobs have either moved inland or to other neighboring countries like Vietnam.

China still needs growth. The leadership generally looks at GDP, which is not always the best indicator of a stable economy. However, I still think it’s reasonable to argue that in order to have an economy large enough to support a population 5 times the size of the US, China needs a national GDP equal to at least 3 times the size of ours.

In order to grow that large with export manufacturing and real estate both slowing down, China will need to support a more entrepreneurial domestic economy. I currently teach English to the children of China’s wealthy. I regularly ask them to pretend they are a member of the standing committee and tell me what changes to policy they would enact in order to create a more innovative and creative economy that eventually will be able to compete on an even playing field with the west. It takes them awhile, but generally they come down to entrepreneurialism without too much prodding or hinting.

Five years ago I said we’d see Chinese banks start offering more small business loans to Chinese general population as a start of the development of a more open, even playing field that would then lead to IP law enforcement. Instead we’re seeing policy changes opening up certain areas (Shanghai has a district like this) to low or tax-free zones for more and more businesses. The higher-ups are lowering regulations. But without access to funds, a private credit rating system, and assurances that Mr. Wang’s new invention won’t be stolen by the more connected Mr. Chen, we will not see the type of growth this country needs to beef up its domestic economy. Without that strengthening, I worry about how this country will continue to grow to a size and scope capable of supporting a solid middle class. But I remain hopeful I’ll see these things soon.

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When should you enter China’s domestic market? (NOW! You might already be too late…)

Posted in Business Culture in China, Doing Business, Macroeconomics with tags , , , , on December 10, 2013 by Ben Brown

Natooke

Here’s what’s going on in China in one quick list of 11 items:

1. New guy in charge.
2. Export manufacturing cycle ending (they already make everything).
3. Need to develop stronger middle class.
4. Production costs increasing.
5. RMB steadily revaluing.
6. Service industry growing fast.
7. Consumers increasingly more savvy.
8. Local brands are weak.
9. Government hungry to add jobs and keep growth steady.
10. Economy still too small to support new graduates at stable, 2% GDP growth.
11. Major policy changes required (and being implemented) to attempt item 3.

Deng Xiaoping once said (I paraphrase heavily here): Poverty is not socialism, to be rich is glorious, some people will get rich first.

The rest of the country has been waiting, increasingly impatiently, to get rich second. China’s next phase of development needs to happen between now and 2024 to continue growing as fast as possible, which will keep the populous satisfied. It will need to focus on a new growth cycle.

In the 80s China worked on bringing farmers and the rural class out of abject poverty. They succeeded to a large scale. In the 90s and the past decade the country focused on FDI, and bringing technology and industry in. In the next decade they will start the painful, complicated process of staying away from the middle income trap. If they are successful, we will see a stable rise in middle-class incomes along with an increasingly higher-value RMB. Suddenly, foreign brands will be available to a higher percentage of people, and anyone who has either established brand recognition or is able to create a great marketing campaign will be able to take advantage of a rapidly growing market.

Developing markets are a lot like blue-ocean strategy opportunities. If you can get a brand in the door and make it popular, you’ll be able to enjoy a quickly-increasing market size. In China, all the conditions are primed. Especially as the interior continues to develop and play catch-up with the coastal cities. To a certain extent, this is what the US has been waiting for. For decades we’ve been buying things imported from China. In the next decade, we may finally be able to start exporting products to China, or to an increasing extent begin manufacturing them there for domestic sale in addition to shipping them back across the Pacific. There are plenty of investors here waiting for the chance to promote US brands in China, and that number too will grow.

China’s Domestic Economy.

Posted in Business Culture in China, Macroeconomics with tags , , , , , on July 5, 2011 by Ben Brown

Chongqing Tree Economic Growth
I know this is going to sound a bit repetitive to the few who have read most of this blog, but China’s domestic growth and economic strengthening is the key to its future viability as a world economic power.

Macro-economic studies, to me, are fascinating in that while the answers to a country’s problems are not always simple, the actions that need to be taken to solve potential challenges to growth are usually quite common and should not be theoretically difficult to implement.

China has boomed since about 1993 or 1994 as a direct result of initiatives implemented by the government to attract foreign direct investment and create jobs through an economy focused on becoming the world’s manufacturer. One of the truly amazing aspects of China’s growth is the speed with which it has accomplished this goal.

All economies, from the world’s largest by population to the world’s smallest, go through stages. China cannot continually grow its GDP at 8-12% annually by simply being the world’s manufacturer. There is a point at which export-focused manufacturing will slow. Once a country is making a large percentage of the world’s mid- to lower-value goods, it will need to have other parts of its economy growing in order to have any hope of sustaining GDP growth at a pace sufficient to continue employing its workforce.

I’m not pretending to tackle all of China’s challenges in one blog. I should probably change the title of this entry to something a little more pin-pointed, like “The role of Chongqing in China’s domestic growth strategy”. I posted about a year ago that China needs to create an environment highly conducive to entrepreneurial start-ups and small businesses. I still believe this to be true. It is one of the main drivers of domestic growth in all developed countries.

Chongqing, and the rest of China, need to create two main things:

1. A stable social support network (health care, social security programs) so that its people will not hoard all of their savings for retirement at a point in their lives when their spending should be supporting the domestic economy.

2. An open economy where people with dreams of starting a small business have access to financial products so they can succeed or fail at their endeavors. This would mean modeling domestic economic policy after the most successful models out there and tailoring them to China’s specific growth needs. A great way to do this is to analyze the IMF’s annual report on ease of doing business in countries across the globe. Where is China ranked low in comparison to the rest of the world’s growing economies? How can it revise its policies so that those rankings increase? This is just one example of how China can really benefit from macro-economic policy.

In the 1980s, according to Huang, Ya Sheng (Capitalism with Chinese Characteristics), China allowed small credit cooperatives in an effort to provide financing for rural start-ups. It needs, in my opinion, to allow for this again. Either that or the big banks in China might want to start focusing a portion of their available funds on start-ups. At the same time China’s central government should direct the local governments to crack down more on intellectual property enforcement. Because of its entry into the WTO, China already has IP regulations in place. It’s part of the requirements for joining the organization. But it hasn’t been enforcing them. This puts a damper on Chinese ingenuity and new technological advancements.

There are a lot of other factors, I know, but that’s my point about macro-economics. In my opinion the answers to any country’s growth challenges, especially if it’s not currently in trouble, are fairly simple. It is the implementation of these changes that can potentially dampen fast-growing economies.

Please feel free to comment on any of my postings. I learn a lot from the feedback.

China’s Exports: A Brief Overview.

Posted in Business Culture in China, Macroeconomics with tags , , , , on April 4, 2010 by Ben Brown

Dani Rodrik, a famous Harvard international economics professor, wrote an article titled “What’s So Special About China’s Exports” in the China and World Economy Journal.

Rodrik posits that taking a country’s per-capita GDP level and comparing it to the quality of its products exported (using internationally accepted 6-digit commodity indicators), then comparing the results to the per-capita GDP of like-quality exporting nations, one can assess whether or not a country is performing above or below expected technological levels. He refers to the product quality / PPP ratio as the EXPY ratio.

In other words, is China exporting more advanced levels of product than its per-capita GDP indicates is reasonable? His research, which is well explained and appears very accurate on its face, indicates that China has not only advanced at a high rate since opening its doors in the late 70s, but has actually risen to a level of productive know-how that far surpasses where it should be in relation to its per-capita GDP. China’s protection of its domestic market, attractive labor costs, low fixed capital costs, policies requiring joint venture agreements from sources of FDI and the tax breaks afforded to foreign investors all led to the development of productive capabilities that far overshot expectations given its income levels.

Fundamentally, a country that exports products at increasingly higher technologically-advanced levels will experience higher per-capita GDP and a more stabilized market. But he argues at the end of the article that China will soon reach a glass ceiling of sorts as its ability to continue producing more advanced-quality products will require higher levels of entrepreneurial R&D and better IPR protections than the country currently offers. Government policies will need to change in order for China’s growth to avoid stagnating.

I firmly agree with Rodrik’s arguments regarding China’s development. I believe that understanding the history of China’s economic policy makes determining challenges to its continued development and the steps it must necessarily take to remain competitive an easier task. Looking at Rodrik’s assessment of China’s current quality-level of productivity in relation to its per-capita income points to a need for economic policies more aligned with a fully-developed country than one still maturing. This indicates that over the next decade, should China want to maintain a minimum growth rate of 6.5% (stated as necessary by government officials to continue providing new jobs for its migrating work force) it must focus on introducing policies more protective of IPR issues and supportive of R&D initiatives.

Cited Works:
“What’s So Special About China’s Exports?” China & World Economy, vol. 14. no. 5, September-October, 2006, 1-19.

Foreign Investment.

Posted in Macroeconomics with tags , , , , on March 11, 2010 by Ben Brown

The following paragraph, taken from my international business law textbook, sums it up perfectly:

“No greater decision can face a firm engaged in international business than the decision to make foreign investments, particularly in the case of active commercial investment (establishment of operations), but equally so in passive portfolio investment (buying securities issued abroad). The firm must decide whether to commit itself to the foreign market in a manner that involves the highest degree of capital investment and the longest commitment to goal achievement, in a situation often difficult to unravel. This all takes place in an environment that may be susceptible to radical change, with the firm’s reduced capability of understanding and adapting to cultural differences. As a result, the commercial potential of such an opportunity should be clear on its face, or capable of explanation in sound and tight commercial terms. If the commercial realities of foreign investment are not well founded, the venture will, at all times, be at serious risk, and no amount of legal creativity will be able to change the situation.” (Willes, International Business Law, McGraw-Hill Irwin, 2005)

When choosing to enter a new market, especially one as complicated and culturally different from ours as China, it is important to do homework. There is no worse reason to go to a foreign country to trade, manufacture or sell than “the competition went in, we have to go in too.” How do we know the competition did their homework? By staying out could we gain advantage and market share as they struggle to keep their foreign business operational and profitable?

Entering a foreign market is about research and reporting. Data collection is key. Get as much information as possible and figure out what it says. Look at the history of growth and the various markets. Get all the numbers together and then perform a statistical analysis of that information to gain at least an educated guess of the chances of success or failure. What are the chances, how great is the swing? Standard deviations for ROI opportunities have to be taken into account.

What is the political environment like? Are you expanding domestically? If so, are you ready for different challenges in each new local government? What will the country look like in five years? Are the state-owned banks going to start lending to local entrepreneurs, and if so, what’s going to happen to your product when suddenly an influx of available cash for small businesses creates a market saturated with competition? If you’re entering China with a consumer good like fried chicken, what do the cultural differences suggest? People from Sichuan province are going to want spicy chicken, people from Beijing will not.

When entering a foreign market, no matter where it might be, all possible risks must be assessed and re-assessed. As the company goes in and starts work, at least once per quarter, and probably once per month, someone in upper management should re-review that report and take a hard look at where the business stands. What are we looking like in reality compared to what we saw on paper? If there are issues, how do we address them? Are we missing something from a cultural perspective that is dragging down morale and making our business less profitable? How do we stay on track? How do we keep the lines of communication open? How do we affect real dialogue with our Chinese counterparts and employees? How, in effect, do we succeed?

The answer to that last question is easy: Homework.

Shanghai: China’s Entrepreneurial Center?

Posted in Macroeconomics with tags , , , , on February 8, 2010 by Ben Brown

To gain a clear picture of China’s economic history and development up to this point, there is no better economist to follow than Yasheng Huang, a professor at MIT.

In his book “Capitalism with Chinese Characteristics” Huang discusses Shanghai’s development at length and uses it to reinforce his argument about the trends of finance and economic development since China opened up to foreign trade and created rules for a demand-side economy.

Dr. Huang argues that China’s development since the 1980s has changed drastically from a domestic entrepreneurial perspective. He makes a strong case that in the 1980s the Chinese banking system was more open than in the 90s or in this most recent decade. Due to China’s desire in the early 80s to bring their rural population out of poverty, Dr. Huang explains how the Chinese Central Party (CCP) encouraged the banking system to promote small business loans and allowed independent, privately and collectively owned financial cooperatives to operate with minimal restrictions.

Dr. Huang also points out that China’s economic rise in the early 80s was unique in that its people took risks that would not otherwise be considered safe by western entrepreneurs. There were no property protections in place when the economy opened up, and no official announcement of its opening in the countryside. There were simply articles like one in the Peoples’ Daily about a farmer who was raising cows for private profit. This was a signal that the market was now privatising to prospective entrepreneurs accustomed to seeing articles about people imprisoned for similar acts.

Dr. Huang points out that when faced with no legal recourse to become an entrepreneur, the simple opening of the market without fear of prosecution provides sufficient impetus to start a business. I agree with Dr. Huang’s point. I also agree with my father, Randy Brown, a much less decorated but highly talented and insightful economist, that in addition to the above theory the rural population’s bleak welfare in 1979 must have played a role. What is the risk in engaging in a private enterprise when there is no money in farming and no alternative future prospect?

The over-arching point, however, is that the CCP instituted a rural entrepreneurship focus in its overall banking strategy that it later reversed after Tiananmen Square. Dr. Huang has three reasons for the reversal:

• The Tiananmen Square incident nearly ushered in a resurgence of supply-side economic policies due to government concerns about loss of control. Financing rural entrepreneurship became a potential threat to government sovereignty.

• Former high-level officials, such as Zhao Ziyang, with rural backgrounds and progressive ideas were replaced by technocrats, like Jiang Zemin, from Shanghai and other urban centers.

• The new technocrats in power concerned themselves with retaining control while bringing in more FDI through joint ventures and open policies. They did this, unfortunately, at the expense of the entrepreneurial policies displayed in the 1980s.

Shanghai, according to Dr. Huang, is a prime example of state-owned enterprises suppressing wage increases for the working class:

“An entrepreneurial economy has a high share of employee compensation (inclusive of proprietors’ income), whereas a statist economy has a low share… Employee compensation comprised 53% of the net regional product in Zhejiang, a full 12 percent higher than in Shanghai. The two provinces have almost identical shares of corporate profits, about 30 percent, which implies that the key difference between the two is the income accruing to the government. For Shanghai, the ratio is 28.9 percent; for Zhejiang, the ratio is 17.4 percent. The upshot of this analysis is that an average resident in Zhejiang captures 10 percent more of each increment in economic output than does her counterpart in Shanghai. She is 10 percent richer but her government is 10 percent poorer.” (Huang, Pg 182.)

Dr. Huang goes on to explain that Shanghai’s SOEs control 39.4 percent of industrial output, compared with a much lower 13.6 percent in Zhejiang, according to the 2003 National Bureau of Statistics in China. This means private income share in Zhejiang is much higher than in Shanghai. He also points out that the Pearson correlation coefficient between Shanghai’s GDP and both its urban and rural incomes is negative; more so for the GDP / rural incomes (-0.62). (Huang, Pg. 185). This suggests that since the 90s, as the ratio between Shanghai’s GDP growth rate and the rest of the country has increased, that of its urban and rural incomes has shrunk.

This makes sense, because one result of reducing financing for entrepreneurial endeavors and increasing it for SOEs was low wages. The rural population that opened businesses in the 80s and expanded into urban areas through them instead migrated there as laborers, which kept labor costs low for manufacturing and assembly operations.

Dr. Huang’s argument, which I agree with, is that China’s overall policy favors SOEs, large firms, and FDI at the expense of small, independent businesses. This lack of financing reduces jobs and incomes in the interior, which leads to migratory laborers. If left unchecked, this could lead to issues down the road. Right now the government is able to pick up the slack in manufacturing jobs with work programs developing the interior infrastructure. But in order to utilize that infrastructure the CCP will need to promote more small business loans. Entrepreneurial finance creates jobs, increases commerce and income, stabilizes local governance through higher tax revenues, and attracts further developmental FDI.

The issue with entrepreneurial finance is that it also tends to increase demands for personal and political freedoms. While I don’t believe this immediately threatens the CCP’s authority, I do believe it is a fear that keeps the party from a change in policy that would bring about true competition and make China a more legitimate threat to the west. With more entrepreneurial freedoms and more small businesses, the ingenuity and competitive spirit displayed in the US and Europe would allow for technological advances across industries by Chinese-owned companies. It would simultaneously allow more western competition. The increase in income would create a huge domestic market for all sorts of products. It would also usher in more stringent IPR protections, as local entrepreneurs would demand them to protect their own R&D initiatives.

Basically, the issues with Shanghai are the issues, modeled on a smaller scale, with the rest of China. Shanghai is a center through which China’s various economic conduits flow. Labor, capital, and investment flow in and out of Shanghai to create a clear anatomy of China’s economic health.

A company hoping to correctly time China’s domestic economy so that it enters the market when consumers can afford its products or services needs to watch how the major Chinese banks disperse loan funds. When they start going out to small businesses, it almost immediately signals an opportunity to move inwards and expand into what will eventually be the largest domestic market, by population, on earth.

Work Cited
Huang, Yasheng. “Capitalism with Chinese Characteristics”. Cambridge University Press. New York. 2008.

China’s Western Development.

Posted in Macroeconomics with tags , , , on September 10, 2009 by Ben Brown

China’s government, though extraordinarily stable in comparison to most of its tumultuous history, still faces challenges to its continued legacy.

There are restless people in the provinces of Xinjiang and Tibet. There are small riots over oil rights when small local governments ignore farmers’ legally defensible claims because they know Beijing is too far away and too preoccupied. There are safety issues with coal mines. The Yellow River is nearly dry year round in the arid north. Pollution runs rampant. The poor remain exceptionally poor in comparison to wealthy entrepreneurs in chauffeured BMWs. One needs only jump on a train for 45 minutes from Shanghai to Anhui province to witness the stark transition from opulence to squalor.

The greatest challenge for the central government, however, has got to be the lack of infrastructure and stability. Migrant workers, as has been the case since the mid 90s, travel from cities and farms all over western China to work in construction and manufacturing on the coast. These workers move annually to cities around centers like Shanghai and Guangzhou to make quick money at stable jobs and send it home to their families.

As the recession hit, the central government faced a problem that needed immediate attention. Farmers from poorer provinces like Sichuan and Shaanxi returned from Shanghai this past Chinese New Year having been told that their jobs, and the factories they worked in, would no longer be in operation when they returned. This has happened with increasing frequency as the globalized economy that made China the world’s manufacturing and assembly center suddenly stopped spending money. In addition to the slowdown and loss of work, the farmers returned to their homes knowing they could not farm their own land, which in many cases they leased out to larger local operators. The money they got from the lease was insufficient to survive on, and they needed work where there was none.

Over the past year or so, Chinese soldiers and police have been at the train stations every day, meeting these immigrants as they returned to their homes with no prospects and little hope, and asked them whether they had plans. If the answer came back “no”, they were handed a shovel and told to take a job with the government building roads, upgrading train stations and tracks, helping with airport remodels and construction, or doing other infrastructure-related work.

China has chosen to combat the recession with a USD $586 billion stimulus package that focuses on development of its western and central regions. Moving development inwards has been long overdue. It will prove beneficial to the country for multiple reasons:

  •  Locals who moved from cities like Chongqing and Chengdu to Shanghai to work in factories now have jobs closer to home.
     
  • As the infrastructure of these inner, second tier cities becomes more developed, China’s well-educated, stable, land-locked cities will suddenly be less of a logistical nightmare.
  •  

  • The lower logistical costs of potential hubs such as Chongqing and Xi’an will make manufacturing for export overseas and domestically a reality.
  •  

    Right now China’s inner, second-tier cities are utilized more for domestic production and services outsourcing than for major export operations. Should China develop its interior to the point where jobs for less-skilled laborers become available closer to home, the country will hopefully see another boom. Opening up the interior and providing job stability and increased incomes for locals should help China’s domestic economy shift from upper middle class development along the coast to blue collar across the interior. When this happens, domestic and foreign companies that have already positioned themselves in the west or at least have an entry plan will find themselves ready to reap the benefits of the next stage of China’s development. In a USA Today article a few months back, Ting Lu, a Merrill Lynch economist stated:

    “If you want to stimulate consumption, and persuade them to buy TVs, washers and fridges, you must provide electricity, running water and TV signals. (China) needs significant infrastructure investment in rural areas.”
    This stimulus package will be a great start. As cities like Chongqing, Chengdu, Xi’an and Kunming become more developed, the increased domestic wealth within provincial governments should bring infrastructure further out into rural areas.

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